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Look for Really Big Investment Bets in the Future

Like it or not, the decisions of central bankers and politicians move markets. Many investors in the UK are sufficiently spooked by this omnipotent power that they engage in a dangerous game of Risk On Risk Off (nicknamed RoRo). When central bankers loosen monetary policies, risk is back on and everyone seems to flock to shares.

But sometimes the ineptitude of politicians (such as their failure to solve the Eurozone crisis with determined, united action) causes a market panic, and suddenly investors move into a risk off phase, dumping risky equities in favour of so-called safe assets such as bonds.

This RoRo trade is dangerous because it encourages people to over-trade and work out a way of second-guessing the markets and the political elite. Crucially, it also means that investors somehow have to develop powers of clairvoyance about the future. In that respect, private investors have the same problem as most hedge funds: no one knows what’s going to happen next and particularly not how key political decisions may affect the global economy.

Maybe, though, that lack of knowledge isn’t so much an impediment as a way of levelling the playing field between hedge funds and individuals. Perhaps the diligent and quick-witted can look at the same big trends (the macro signals) and work out their own tactical short-term trading strategy.

If that’s the case, what big moves should you be looking for that may profoundly change the global financial markets? Five big trends suggest themselves, all fairly self-explanatory, and each with its own, fairly obvious investment implication:

  • The return of inflation: At some point the big western economies will recover sufficiently for prices to start rising. Construction may boom, and wages start increasing. More to the point, central bankers may try to convert all their monetary intervention into new money supply, adding oil to the fire. When that happens, you may see inflation measures such as the retail price and consumer price indices shoot up. That would be an obvious sell signal for all conventional (non-indexed linked) bonds.

  • Japanese chaos: The Japanese government is running up a huge budget deficit in order to kick-start its economy. This fiscal and monetary pump priming has resulted in a massive expansion of the Japanese state debt, to more than 200 per cent of GDP. At the moment that deficit is being funded by Japanese savers but as soon as Japan starts running up a current account deficit ‒ and no more new local Japanese bond buyers emerge ‒ its government has to start thinking about funding its requirements from external investors.

    These investors are presumably going to want higher interest rates, which would cripple local budgets. That would prompt a possible run on Japanese state bonds and a sudden sharp decline in the value of the Japanese yen relative to the dollar.

  • Recovery in the US housing market: Eventually the US housing market will bottom out, with prices in key regions stabilising and then even increasing. If and when this happens, the result may be in a boost for US consumer confidence, renewed levels of personal borrowing and more new home-construction starts.

    That would be good news for US house-building shares, good news for China as the US consumer starts spending again and good news for the US dollar.

  • China rising: As China continues to expand its consumer economy, local inflation rates must remain at elevated levels. Eventually Chinese consumers are going to choose to spend more of their money on local consumer goods and interest rates will start to rise: good news for local Chinese shares and the renminbi currency.

  • Panic about the US’s dominant economic status: The US housing market may recover but many investors remain hugely worried about the government’s vast debts and massive deficit. The combined willpower of the US political elite may work out a way to combat this massive debt mountain, but a chance remains that debts will continue to rise and the dollar start to weaken.

    Investors may choose to switch many of their US Treasury Bill and Bond holdings offshore, putting yet more downward pressure on the US dollar and encouraging a panic about the dollar’s strength. This currency depreciation may push local inflation rates up and cause a sudden increase in interest rates. A massive bonds sell off would then occur and the US recession lurch into a deep recession.

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